Insider trading is the trading of a security of a company (e.g., shares or options) by an insider, a person who knows information that is not accessible to the public. Illegal inside trading occurs when the insider violates a fiduciary duty or other relationship of trust and confidence by virtue of the insider trading. Thus, some insider trading is legal and other is illegal, depending on whether there is a breach of trust. Generally, however, the term is used in the context of trades improperly using insider information.
An example of illegal insider trading may be that you, as an assistant to the Chief Executive Officer, learn that your company is going to be taken over before it is announced to the stock exchange. Knowing that such a move is liable to cause the price to rise, you buy shares in the company and subsequently profit from the transaction.
Within a company, there are many people who might have access to information that might be construed as privileged to their position in the company. Nevertheless, they may wish to trade in the shares of their company (e.g., selling share options). To ensure that their employees can easily comply with the regulations, these companies will often publish dates when managers and senior staff members can trade in shares of the company without breaking the law.
There are rules against such insider trading in most jurisdictions around the world, though the details and the efforts to enforce them vary considerably.
In practice, prosecutions for insider trading tend to be rare and difficult to win for a variety of reasons. It can be difficult to prove what the accused actually knew at the time the trades were made -- and people may not even be told directly but merely advised to buy or sell with a nudge and wink. Proving that a particular individual was responsible for a trade can also be difficult, because a clever trader can hide behind a variety of nominees, companies, and proxies, some of which may be located offshore in jurisdictions that don't cooperate with the local authorities. Insider trading is usually performed by the already wealthy, who can afford the best lawyers available and have the resources to drag a case out and cost the prosecutors millions along the way. Finally, the details of insider trading can be highly confusing to non-experts, and convincing a randomly-selected jury, many with no experience of share trading, that a crime was committed can be difficult.
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External Link
- Informational page from the U.S. Security and Exchange Commission (SEC)
